The markets expect several interest rate cuts from central banks this and next year. Inflation, which previously played a key role, has receded into the background and interest rate cuts are now marching to the tune of the US labour market.
In July and August, the equity markets experienced turbulence but they have already almost fully recovered. In Europe, equities have risen to new all-time highs, and in the USA, the market is approaching the level from which the plummet began in the first place.
In the United States, the Fed is expected to start its rate cuts at its meeting on 18 September. The economic data released before this will, however, determine how large the Fed’s rate cut will be. We can expect a rate cut of at least 25 basis points but a 50-basis-point rate cut is not impossible depending on the economic data.
Economic growth is monitored closer than ever on the markets. During the summer, the economic outlook weakened but recently has showed some signs of perking up, and August’s economic data has exceeded expectations.
Where earlier both the markets’ and the central banks’ main topic was inflation, their focus has recently moved away from this theme. One of the main factors behind this shift in focus can be considered the Fed which has stated, via its Chair Jerome Powell, that inflation has fallen into the background on their radar. Inflation has not yet fully reached the hoped-for level, but it is no longer a similar cause of concern as a year ago.
Right now, tensions are maintained by the labour market, which the Fed is now zoning in on as the key factor impacting the interest rate level. The next US labour market report will be released on Friday this week. It will be closely monitored by the markets because the previous report was clearly weaker than anticipated.
Recently, the US labour market has even shown signs of overheating but the balance between good and bad slowing is delicate. If the labour market weakens too much, consumers’ finances will be overly affected, which will in turn contribute negatively to the country’s economic growth.
At the start of the year, the markets expected six rate cuts by the Fed, for example, for this year. Since then, expectations have been dialled back several times and currently the forecast is that both the Fed and the European Central Bank (ECB) will carry out roughly four rate cuts this year. The ECB has already carried out its first one, unusually before the Fed, but the Fed is believed to set the pace going forward.
What is interesting is that the markets’ rate cut expectations for both the Fed and the ECB for next year have continued to grow – both are expected to carry out four rate cuts next year too. If economic growth does not weaken significantly and the central banks were to implement four rate cuts this year, next year’s forecast of four rate cuts is relatively large.
The markets are expecting equity market volatility for September, i.e. an increase in price fluctuations, driven by, among other things, the approaching US presidential elections. Also historically, the month of September has often been challenging for the equity market.
Also of interest are the almost opposite directions that the central banks have taken, especially the USA and Japan, for example in terms of interest rate policies and how this may affect the equity and fixed income markets.
Additionally, the equity market rotation, which began briskly in July but has since slightly dwindled, may also play a role in September. This month will likely reveal whether the earlier rotation will continue or whether large caps will return to the top with the Magnificent Seven in the lead.
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